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Investing in Commodities

Investing in Commodities. Torbjörn Iwarson, +46 8 701 1443, toiw01@handelsbanken.se. Returns on shares, bonds, commodities and gold in SEK. Stocks top before the top, commodities at and gold after. Output gap and stocks (MSCI), commodities (GSCI) and gold. 1970-2006. The Futures price.

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Investing in Commodities

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  1. Investing in Commodities Torbjörn Iwarson, +46 8 701 1443, toiw01@handelsbanken.se

  2. Returns on shares, bonds, commodities and gold in SEK

  3. Stocks top before the top, commodities at and gold after • Output gap and stocks (MSCI), commodities (GSCI) and gold 1970-2006

  4. The Futures price storage conv. yield S = spot price T = time in years e = 2.718 r = risk free rate of interest u = storage cost y = convenience yield The price of wheat Futures price = Spot price + interest – convenience yield + storage cost

  5. Crude oil in contango / backwardation • Nymex light sweet crude oil front month, contango/backwardation • 3346 days in backwardation (59%) • 0.7% in backwardation on average ( - per month!!) Contango Backwardation

  6. GSCI crude oil index • January 1987 = 100

  7. Commodity indices For a broad exposure to the commodity markets

  8. Index • Goldman Sachs Commodity Index (GSCI) • Dow Jones – American International Group Commodity Index (DJ AIGCI)

  9. GSCI • Weighting is based on the last five years’ global production of commodities. • 24 commodities • Start 1970 • Futures on CME • GSCI is the most commonly used index for commodity investments. NB! Very heavy on energy. - Why not just buy crude?

  10. DJ AIGCI • Based on the last five years of global production and liquidity. • No group can weigh more than 33% • No commodity can have a weight less than 2% • Futures on CBOT (ticker AIF) (NB! Natural gas + Petroleum = 33%)

  11. The return from GSCI The bulk of returns the last 35 years does not come from price return. What drives total return is independent from stocks and bonds. => diversification! Note that GSCI has had negative roll return lately due to contango in oil. Source: ECOWIN, Handelsbanken

  12. Actually pretty simple to trade futures in Sweden www.handelsbanken.se/trader • Handelsbanken Capital Markets TraderOn-Line • 79 kr per contrakt (0.02% commisson). • Account in SEK. • Direct access to 400+ futures contracts on 17 exchanges (COMEX, CBOT, etc).

  13. Return and risk for each asset class Return 1971-2005 geometric mean Return Stocks GSCI Gold Bonds Risk Return 1971-2005 aritmethmetic mean

  14. Returns at market crashes • 15 months between 1971 and 2005 the AFGX has fallen by more than 10%. • During these months the return has been: • Gold and ”commodities” perform well when everything else performs poorly.

  15. Efficient frontier with and without commodities and gold The efficient portfolio contains 26% stocks, 1% gold, 17% GSCI och 56% bonds.

  16. Sharpe ratios • With 10% GSCI you get a portfolio with a higher Sharpe-ratio, higher return and lower risk and better worst outcome. *) 45% stocks, 45% bonds, 10% GSCI **) 45% stocks, 45% bonds, 10% guld

  17. Asset allocation as a function of risk aversion We use a quadratic utility function which has the form: Expected utility. Portfolio return Portfolio variance b is a measure of relative risk aversion. b=0 is risk neutral, b=6 extremely risk averse See E.G. Anson, M: ”Maximizing Utility with Commodity Futures Diversification”, the Journal of Portfolio Management, Summer 1999.

  18. Only stocks and bonds

  19. Stocks, bonds commodities, gold Commodities take allocation from stocks for low levels of risk aversion, but from bonds at higher levels of risk aversion

  20. Stocks, bonds, gold

  21. Risk premia • 5 yr bonds = 20-30 bp. • Swedish stock market: 5.4% • Dimson, E., Marsh, P., Staunton, M.: Global Investment Returns Yearbook 2004, London Business School / ABN Amro, Februari 2004. (based on data between 1900 and 2003) • Commodities: 5.23% • Gorton, G., K. G. Rouwenhorst (2005): ”Facts and Fantasies about Commodity Futures”, Yale International Center for Finance, Working Paper No. 04-20, February 28, 2005. (based on 45 years of data.)

  22. The portfolio optimiser run backwards… • A 50/50 portfolio of stocks / bonds is common. It is attained at a risk aversion of 1.05. • Assume we add GSCI… One should then have 44% stocks, 39% commodities and 16% bonds. • To motivate an allocation of 5%, which institutions often have has initial allocation, commodities must have a return over t-bills of 1.81%. • Historically the risk premium has been 5.23%.

  23. Will the risk premium go away? • Will the risk premium go away for 5 year bonds? • Will the risk premium go away for stocks? • Why would commodity investors be more stupid?

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